Financial Management · Hedging techniques for foreign currency risk

Forward Contracts and Money Market Hedges Step by Step

Updated 11 October 2026 · Fact-checked

A forward contract fixes today the rate at which you will buy or sell foreign currency later. A money market hedge does the same job by borrowing and depositing now, then converting at spot. Calculate the home-currency outcome of each, then choose the better one: the lower cost for a payment, the higher receipt for a receipt.

Understand Forward Contracts and Money Market Hedges

A company that must pay or will receive foreign currency later is exposed to transaction risk. If the rate moves against it before settlement, the home-currency cost rises or the receipt falls. Hedging removes that uncertainty by locking in an outcome today.

A forward contract is the simple route. You agree with a bank now to buy or sell a set amount of currency on a set future date at a set rate. The bank's forward rate already reflects the interest-rate difference between the two currencies. You only multiply the foreign amount by the correct forward rate.

A money market hedge copies the forward contract using the interest markets. The idea is to create a foreign-currency asset or liability today that exactly matches the future receipt or payment. You then convert at today's spot rate, so the future exchange rate no longer matters.

For a payable, you will need foreign currency later. So you deposit foreign currency now, in an amount that grows to the payable. You buy that amount at spot using home-currency borrowing. In the future, the deposit pays the supplier and you repay the home loan.

For a receivable, you will receive foreign currency later. So you borrow foreign currency now, in an amount that grows to the receivable. You sell it at spot and deposit the home currency. In the future, the receipt repays the foreign loan and you keep the home deposit.

Both methods give a certain outcome. The two results are usually close, because interest rate parity links forward rates to interest rates. Exam questions ask you to calculate both and recommend the better one. They may also ask you to mention other methods, such as futures or options, or to comment on practical points.

Key rules to remember

Forward contract outcome: Home currency amount = foreign amount × forward rate; Use the rate that is worse for you. A customer buying foreign currency uses the bank's selling rate. A customer selling foreign currency uses the bank's buying rate.
Choosing the side of a bid-offer quote: Quoted as home per 1 foreign (e.g. $/€ 1.2000 – 1.2100): customer receiving foreign currency uses the lower rate; customer paying foreign currency uses the higher rate; If the quote is foreign per 1 home, the logic reverses: divide, and use the rate that gives you less. Always check how the quote is written.
Periodic interest rate: Rate for the period = annual rate × (months ÷ 12); Exam questions usually use simple interest for periods under a year unless told otherwise.
Money market hedge for a payable: Foreign deposit now = foreign payable ÷ (1 + foreign deposit rate for period). Home cost now = deposit × spot (selling rate). Future home cost = home cost now × (1 + home borrowing rate for period); If the company already has spare cash, use the home deposit rate as the lost interest instead of the borrowing rate, and say so.
Money market hedge for a receivable: Foreign loan now = foreign receivable ÷ (1 + foreign borrowing rate for period). Home proceeds now = loan × spot (buying rate). Future home receipt = proceeds × (1 + home deposit rate for period); If the company has an overdraft, the proceeds can instead reduce the overdraft, saving the home borrowing rate.

How to solve Forward Contracts and Money Market Hedges questions

Use this method for any forward or money market hedge question. Work in the same order every time and label each line.

1Identify the direction: is the company paying or receiving foreign currency, how much, and when? Note the home currency.
2Pick the correct side of every bid-offer quote. Write down which rate you are using and why before you calculate.
3Forward contract: multiply the foreign amount by the correct forward rate. This is the certain home-currency outcome.
4Money market hedge: decide whether you deposit (payable) or borrow (receivable) the foreign currency. Convert the annual rate to the period rate, then discount the foreign amount to today's value.
5Convert today's foreign amount at the correct spot rate. Then borrow (payable) or deposit (receivable) the home-currency amount at the home rate for the period.
6Roll the home amount forward with interest to the settlement date. This is the money market outcome.
7Compare the two outcomes on the same date. Choose the lowest cost for a payment or the highest receipt for a receipt. State the difference.
8Add brief comment if asked: both are certain, an unhedged position could do better or worse, and a forward contract is simpler and binding.

Quickest way: Payable: deposit now. Receivable: borrow now.

When to use it: Use this in Section B or C when you have limited time and need the numbers fast.

Write the rule on your scratch pad: payable = deposit foreign, borrow home; receivable = borrow foreign, deposit home.
Calculate the forward outcome first. It is one line.
Divide the foreign amount by (1 + period rate) once, using the foreign rate.
Multiply by spot once, then multiply by (1 + period rate) once, using the home rate.
Compare both figures and write one sentence of recommendation with the difference.

Common mistakes in Forward Contracts and Money Market Hedges

Using the wrong side of the bid-offer spread.
Students pick the first or second rate without thinking about who is buying and selling.
Fix: Remember the bank always gives you the worse rate. Write 'bank buys' or 'bank sells' beside the rate before using it.
Using the annual interest rate for a three- or six-month period.
Rates are quoted per year and students forget to adjust for the time.
Fix: Multiply the annual rate by months ÷ 12 as your first step. Write the period rate down.
Multiplying instead of dividing when finding the foreign amount to deposit or borrow today.
Students grow the foreign amount forward instead of discounting it back to today.
Fix: The foreign amount today must be smaller than the future amount for a deposit or loan. Divide by (1 + rate) and check the answer is smaller.
Mixing up deposit and borrowing rates.
Both rates are given for each currency and the choice depends on direction.
Fix: Ask whether you are depositing or borrowing in each currency. Use the deposit rate for deposits and the borrowing rate for loans.
Comparing outcomes at different dates.
The money market hedge gives a figure today after conversion, and students compare it with a future forward figure.
Fix: Always roll the home-currency amount forward to the settlement date with interest before comparing.
Giving the numbers but no recommendation.
Students run out of time after the calculations.
Fix: Finish with one sentence: name the better method, say whether you want the lower cost or higher receipt, and give the difference.

Worked examples

Example 1

A company with the dollar ($) as its home currency must pay a supplier €500,000 in three months. Spot $/€ is 1.2000 – 1.2100. Three-month forward $/€ is 1.2150 – 1.2250. Annual interest rates: $ borrowing 5%, $ deposit 3%, € borrowing 4%, € deposit 2%. Compare a forward contract with a money market hedge and recommend which to use.

Show the solution

The company pays euros, so it buys euros from the bank. The bank sells euros at the higher rate in each quote: spot 1.2100 and forward 1.2250.
Forward contract: €500,000 × 1.2250 = $612,500.
Money market: the company needs euros in three months, so it deposits euros now. The three-month euro deposit rate is 2% × 3/12 = 0.5%.
Euros to deposit now = 500,000 ÷ 1.005 = €497,512.44.
Buy these euros at spot 1.2100: 497,512.44 × 1.2100 = $601,990.05.
Borrow this amount in dollars. The three-month dollar borrowing rate is 5% × 3/12 = 1.25%.
Dollar debt after three months = 601,990.05 × 1.0125 = $609,514.93.
Compare: forward $612,500 against money market $609,514.93. The money market hedge is cheaper by about $2,985.

Answer: Use the money market hedge. It costs about $609,515 in three months, compared with $612,500 under the forward contract, a saving of about $2,985.

Example 2

A company with the dollar ($) as its home currency will receive €400,000 in six months. Spot $/€ is 1.2000 – 1.2100. Six-month forward $/€ is 1.2080 – 1.2180. Annual interest rates: $ borrowing 5%, $ deposit 3%, € borrowing 4%, € deposit 2%. Compare a forward contract with a money market hedge and recommend which to use.

Show the solution

The company receives euros, so it sells euros to the bank. The bank buys euros at the lower rate in each quote: spot 1.2000 and forward 1.2080.
Forward contract: €400,000 × 1.2080 = $483,200 in six months.
Money market: the company will receive euros, so it borrows euros now. The six-month euro borrowing rate is 4% × 6/12 = 2%.
Euros to borrow now = 400,000 ÷ 1.02 = €392,156.86.
Sell these euros at spot 1.2000: 392,156.86 × 1.2000 = $470,588.24.
Deposit the dollars. The six-month dollar deposit rate is 3% × 6/12 = 1.5%.
Dollar deposit after six months = 470,588.24 × 1.015 = $477,647.06.
The €400,000 received then repays the euro loan, which has grown to exactly €400,000.
Compare: forward $483,200 against money market $477,647. The forward contract gives about $5,553 more.

Answer: Use the forward contract. It gives a certain receipt of $483,200, compared with about $477,647 from the money market hedge.

Exam tips

Write a one-line plan before calculating: 'Payable: deposit € and borrow $'. This protects marks even if you slip on arithmetic.
In objective test questions, the trap is usually the wrong side of the spread or a forgotten period adjustment. Check both before choosing an option, because objective test answers are marked all or nothing.
In constructed response questions, lay out each method under a clear label with every step on its own line. Marks are given for method, so follow-through errors still earn credit.
Always finish with a recommendation and the difference between the two outcomes. Add one or two comments, such as certainty of outcome, binding commitment, or the option to leave the position unhedged.
If the question gives the company's cash position, use it. A company with surplus cash loses deposit interest instead of paying borrowing interest, and your home-currency rate must change accordingly.

Practice questions from Hedging techniques for foreign currency risk

Forward Contracts and Money Market Hedges in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Forward Contracts and Money Market Hedges: frequently asked questions

How do I do a money market hedge for a payable?

Deposit foreign currency now in an amount that grows to the payable, using the foreign deposit rate for the period. Buy that currency at spot with borrowed home currency. At settlement, repay the home loan with interest and pay the supplier from the deposit.

Which is better in ACCA FM, a forward contract or a money market hedge?

Neither is always better. Calculate both and choose the lower cost for a payment or the higher receipt for a receipt. The results are usually close, so the difference may be small.

Why do I borrow foreign currency for a receivable?

The future receipt will repay the foreign loan, so the company's foreign exposure is removed. The borrowed currency is sold at spot for home currency today. The home currency is then deposited or used to cut an overdraft.

Do I use annual or period interest rates?

Use the period rate. Multiply the annual rate by months ÷ 12 for simple interest, unless the question tells you otherwise. Do this for both currencies before any other step.